Banking in Europe: What went wrong and how to fix it? Boris Vuji e-mail: [email protected] Structure of the presentation Overview of the European banking sector Lending and asset quality Capital and funding Deleveraging Banks and sovereigns Government intervention Reform of the architecture banking union Single supervisory mechanism Resolution mechanism and deposit guarantee scheme View from a possible opt-in country: to join or not to join? 2/35
Credit activity across the euro area Loans to private sector in euro area have stagnated since the start of the financial crisis (cumulative nominal growth in five years amounted to 0.8%, meaning effective decrease). However, huge differences among countries: stock of loans varies from 60% to130% of the pre-crisis level a number of member states experience serious credit crunch. 3/35 Overall stagnation in lending but large differences among the euro area countries Cumulative credit growth 9/2008 7/2013 Source: ECB and CNB. 4/35 Banks assets structure and market disintegration in the euro area Data on lending show that financial markets became increasingly fragmented.
Moreover, banks in euro area increased share of domestic bonds holdings with the bulk of domestic bonds purchases referring to government bonds. Government bonds, on one hand, seemed like a reasonable (CAR supporting) investment in the period of high risk aversion, credit risk increase and low private sector demand. On the other hand, such an increasing exposure towards domestic governments further strengthened the link between banks and sovereigns. 5/35 Increasing home (government) bias in euro area and Croatia Domestic bonds to total bonds Government Securities/(Government Securities + 25Loans to private sector) 100 80 20 60
15 September 2008 July 2013 September 2008 Croatia Estonia France Greece Netherl. Luxemb. Finland Belgium Germany Cyprus Slovenia Slovakia Malta Austria Italy Ireland Croatia Finland Netherl.
Italy Greece Spain Luxemb. Portugal 0 Austria 0 France 5 Belgium 20 Germany 10 Ireland 40 Spain Portugal %
% July 2013 Source: ECB. 6/35 Asset quality of European banks continuously declines Non-performing loans continue to increase, making a value adjustment cost decrease unlikely. Besides the NPLs increase, value adjustment costs rise due to a need to further provision the existing NPLs. US in a better shape. In Croatia, NPL coverage is lower, but the proportion of recognized NPLs is higher 7/35 Asset quality
2010 Eurozone 2011 2012 United States 2008 Croatia 2009 CEE 2010 Eurozone 2011 2012 United States Source: IMF, FSI, (bank assets) weighted averages. Note: CEE countries: Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovak Republic and Slovenia. 8/35 Bank performance Bank earnings in Europe strongly affected by deteriorating assets,
while in US provisions are decreasing and, thus even supporting the earnings. Accounting/provisioning standards? Double impact of rising non-performing loans: value adjustment costs increase and interest income decrease. US banks operating with lower operating profitability but, with assets of higher quality and less leverage, have more credit potential. Croatian banks fared well in most of the crisis period; however, prolonged recession started to weight in on the banks performance. Credit risk materialisation plays an increasing role in banking, with interest income starting to suffer. 9/35 Bank performance indicators Bank Return on Assets Bank Return on Assets excluding value adjustment costs 2.5 2.0 2.0 1.5
2010 Eurozone 2011 2012 United States Source: IMF, FSI, (bank assets) weighted averages. Note: CEE countries: Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovak Republic and Slovenia. 10/35 CAR in Europe relatively high but also high leverage!? United states traditionally has higher capital ratios. CAR ratios in Europe increased after the crisis, mostly due to a risk aversion. On the other hand, equity to un-weighted assets ratio remains stable (even decreased slightly in euro area after 2010), meaning that the fresh capital inflow in the banking sector has been scarce there has been no deleveraging.
In Croatia, high capital buffers make banking sector much more resilient to the crisis and change of regulatory standards than elsewhere. 11/35 CAR in Europe is improving but without corresponding decline in leverage Bank (regulatory) capital adequacy ratio (CAR) Bank capital to unweighted assets 22 16 20 14 18 12 % 16 % 10 14 8
2012 United States Source: IMF, FSI, (bank assets) weighted averages. Note: CEE countries: Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovak Republic and Slovenia. 12/35 Costs of financial aid in the EU, 20082011: costly crisis EU27 members approved around 4,656 billion euros of financial aid to banking institutions (with 1,676 billion spent until the end of 2011). United Kingdom, Germany, Denmark and Ireland approved more the 500 billion euros, while Bulgaria, Czech R., Estonia, Malta, Romania and Croatia did not provide any help to their banks. Relative to 2011 GDP, the highest bank support was provided by Ireland (328 %) and Denmark (258%), with Belgium and the Netherlands committing more than 50% of GDP. The structure of EU27 bank support shows that countries mostly used guarantees to support banks (27.3%), with recapitalization,
buying of troubled assets and liquidity measures amounting to 4.9%, 3.6% and 1.7% of 2011 GDP respectively. 13/35 Belgium Bulgaria Czech R. Denmark Germany Estonia Ireland Greece Spain France Italy Cyprus Latvia Lithuania Luxemb. Hungary Malta Netherl. Austria Poland Portugal Romania Slovenia Slovakia Finland Sweden UK EU-27 Belgium Bulgaria
Czech R. Denmark Germany Estonia Ireland Greece Spain France Italy Cyprus Latvia Lithuania Luxemb. Hungary Malta Netherl. Austria Poland Portugal Romania Slovenia Slovakia Finland Sweden UK EU-27 100 80 % 60 40
20 0 900 800 700 600 500 400 300 200 100 0 Amount approved as yearly average % of GDP The structure of approved financial aid Source: European Commission. Guarantee Recapitalization billion EUR Costs of support to financial system 20082011 The amount of approved financial aid Amount approved in absolute terms- right
100% 80% 60% 40% 20% 0% Acquired troubled assets Liquidity meassures 14/35 Significant risks remain Unlike in the USA, European banks capital is increasingly burdened with unprovisioned NPLs. Even without further NPL increase, resolving the current asset quality issue would take time and it implies spending some buffers or gathering additional capital. Two risks arise from the bank asset quality: a) Fiscal risks arising from NPL resolution b) Dampening of potential credit growth in the following years
In Croatia, the heavier burden of NPLs on capital is offset with high capital buffers. Even after correcting the capital ratio for the unprovisioned NPLs, Croatia has relatively higher capital ratios. 15/35 Capital to assets US UK Sweden Spain Slovenia Slovak R. Romania Portugal Poland Netherl. Malta Luxemb. Lithuania
Latvia Italy Ireland Hungary Greece Germany France Finland Estonia Denmark Czech R. Cyprus Croatia Bulgaria Belgium Austria Capital ratios are sensitive to NPL coverage Capital ratios, end-2012
15 10 5 % 0 -5 -10 (Capital-uncovered NPLs) to assets Source: IMF, FSI. 16/35 European banks remain reliant on whole-sale funding (ECB) Deposits of banks in the USA exceed their loans, with the LTD ratio decreasing continuously. Euro area banks, on the other hand, even increased slightly their reliance on whole-sale funds (ECB). CEE countries started to deleverage in 2012. Before the crisis, the share of foreign liabilities in total liabilities
was relatively high due to high penetration of foreign banks. 17/35 With little new capital, euro area banks remain reliant on wholesale funds (ECB) Loan to deposit ratio (Change of Equity)/Assets 2.0 150 1.5 120 1.0 % % 0.5 90 0.0 -0.5 60 2008 Croatia 2009 CEE 2010
Eurozone 2011 2012 United States 2009 Croatia 2010 CEE 2011 Eurozone 2012 United States Source: CNB and IMF - FSI, (bank assets) weighted averages. Note: CEE countries: Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovak Republic and Slovenia. 18/35 CEE: unlike in the euro area, higher LTDR more deleveraging Change in banks' external debt between March 2013 and September 2008 5 Loan to deposit ratio
2.3 0 1.9 -5 as % of GDP in 2012 2.1 1.7 1.5 1.3 1.1 0.9 -10 -15 -20 -25 Croatia Poland Czech R. Romania Bulgaria Baltics 2012
Slovak R. Central Europe Croatia 2011 Lithuania 2010 Hungary EU periphery SEE 2009 Latvia 2008 Slovenia 2007 Estonia -30 0.7 Sources: CNB and national central banks.
19/35 Banking union P. Romer: A crisis is a terrible thing to waste! Incomplete supervisory architecture not the only (and not even a major) cause of the crisis, but the crisis has laid ground for an integration of banking supervision in the euro area not only in the form of common rules and practices but also as an institutional integration of supervisory authorities. BU becomes a necessary precondition (although not a sufficient one) of breaking the link between weak banks and weak sovereigns. 20/35 BU architecture Banking Union 1. Single Supervisory Mechanism (SSM) 2. Single Resolution Mechanism (SRM)
3. Harmonised Deposit Guarantee Schemes (DGS) Common rules (Single Rulebook) Common supervisory practices (Single Handbook) 21/35 Link between weak banks and weak sovereigns The contagion channel between a sovereign and banks Sovereign Banks Lower market value Rising sovereign risk Equity Government bonds Government bonds Debt Rising solvency concerns
Higher funding costs Loans Contingent liabilities Lower tax revenues Higher bail-out probability Lower credit growth Real economy Deleveraging pressure Weaker economic growth IMF (2012), Global Financial Stability Report, April. 22/35 Single supervisory mechanism, banking union and the EU Source: ECB. 23/35 BU advantages in general
Improving the regulatory framework More effective supervision timely intervention, less likely to be captured! Common safety nets and backstops breaking the link between banks and sovereigns Together, these should eventually reduce social costs of financial crises Harmonization of banking regulation and supervisory practices should improve the assessment of banks and banking systems Less need for cross-border coordination Reduced compliance costs Benefits and costs of macro-prudential policies internalized on union24/35 wide level Advantages for non-euro area countries? Fostering financial integration
Providing better information on cross-border banks and improving their supervision Streamlining some of the supervisory colleges Ensuring greater consistency of supervisory practices Avoiding distortions in the single-market 25/35 Challenges of SSM participation for a non-euro area country Participation in the decision- making process Serious efforts have been made to enhance participation of non-euro area MS in decision- making bodies, but some restrictions remain. The final form of the banking union is still not known We have almost 1 of the 3 pillars agreed on paper. Making a decision early is a leap into the unknown, one of the main risks being what a future resolution of a crossborder bank will look like. Two different supervisory and bank resolution regimes may tilt the playing field and lead to competitive distortions But not even a single supervisory regime is likely to set the level playing
26/35 Challenges of SSM participation for a non-euro area country (2) Accountability and potential costs are major issues The decision is made within the SSM framework, but national authorities perform resolution and bear the costs. SSM participation may impede the functioning of national macro-prudential policies. ECBs lack of supervisory experience and the need to create institutional capacity for supervision or macroprudential policies at the ECB level. Subsidiaries operating in small states may get under the radar. Just having a parent in the BU may help reap some of the benefits. 27/35 SSM timeline Conduction of Asset Quality Review
The comprehensive assessment comprises three main components: Risk Assessment System (RAS) Balance Sheet Assessment (BSA) Targeted Asset Quality Review Joint Stress Test EBA and ECB 28/35 Balance Sheet Assessment 29/35 What about the other two pillars? The draft Recovery and Resolution Directive was recently presented although it has many sensible elements that will remove some uncertainty and strengthen market discipline, it leaves member states with too much discretion, making competitive distortions likely. Single supervision cannot work properly without an effective resolution authority and a credible financing mechanism. It also needs effective decision-making structures all of which the SRM does not deliver at this point. Difficult political issue Juncker: We all know what to do, but dont know how to go back home after that and get re-elected. Deposit guarantee scheme complicated legal and practical issues.
Pan-EU Deposit Guarantee Scheme? Member states use various schemes, so this would mean a longer-term project. 30/35 Deposit guarantee scheme harmonization Credible DGS: appropriate coverage, timely payouts and adequate funding. Harmonization among EU MS started after 2008 Directive 2009/14/EC imposed the obligation to explore further elements of harmonization of DGS, but set no timeline as regards its implementation. Further harmonization of EU deposit guarantee schemes has been suspended pending the adoption of EU bank resolution arrangements through a new Directive. However: The role of the deposit insurance agency varies widely, both within the EU and worldwide. Lack of common EU funding standards:
Nominally, most of the countries have ex-ante funding (pre-funding) Effectively, in many instances (i.e. in the case of systemic events), these are ex-post funding schemes since pre-funding is relatively modest. 31/35 Differences in DGS among countries Funding mechanism for DGS Insured deposits and DGS funds in some EU countries, end-2011 Notes: Eligible deposits is the sum of MFI household and corporate deposits. Covered deposits applies the EC coverage ratio to eligible deposits. * DGS or IMF staff info at end-2011, ** Banking associations top up the mandatory scheme, hence coverage ratio is lower bound. Source: IMF Country Report No. 13/66 Technical Note on Deposit Insurance. Source: European Commission, JRC Report under Article 12 of Directive 94/19/EC. Insured deposits and DGS funds in Croatia, end-2012 Eligible deposits/GDP 0.86 Covered deposits/GDP DGS fund size/GDP 1.21 0.44 Source: State Agency for Deposit Insurance and
Bank Rehabilitation and Croatian Bureau of Statistics 32/35 To conclude 33/35 To conclude Setting up the BU will take time and effort. Croatia is very supportive of setting up the BU, but the BU is currently set in such a way to increase the option value of waiting for non-euro area member states. Postponing the decision a bit doesnt entail high costs, but making the decision now potentially does. What could make SSM membership more attractive to noneuro area members? Access to resolution funds (the use of BoP assistance could be a useful substitute) or liquidity assistance, level playing field when it comes to deposit insurance. Overall, a more complete BU is more attractive than an incomplete one! 34/35 Thank you! 35/35
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